DaVita Inc. Fundamental Analysis

Changes in clinical practices, payment rates or regulations impacting pharmaceuticals may impact DaVita Inc.’s business and operations and may negatively impact its ability to care for patients.

For example, Medicare bundles certain pharmaceuticals into the ESRD PPS payment rate at industry-average doses and prices. Variations above the industry average may be subject to partial reimbursement through the PPS outlier reimbursement policy. Changes to industry averages, which can be caused by, among other things, changes in physician prescribing practices, including in response to the introduction of new drugs, treatments or technologies, changes in private or governmental payment criteria regarding pharmaceuticals, or the introduction of administration policies may negatively impact DaVita Inc.’s ability to obtain sufficient reimbursement levels for the care that the company provides, which could affect the business and profitability.

Next, a substantial portion of DaVita Inc.’s dialysis revenue is generated from patients who have Medicare as their primary payor. For patients with Medicare coverage, all ESRD payments for dialysis treatments are currently made under a single bundled payment rate which provides a fixed payment rate to encompass all goods and services provided during the dialysis treatment that is related to the treatment of dialysis. Changes in the structure of and payment rates under the Medicare ESRD program or changes in state Medicaid or other non-Medicare government-based programs or payment rates could have a material adverse effect on the company’s financial condition and cash flows.

Summary for DaVita Inc.

DaVita Inc.’s economic moat stems from its intangible assets, cost advantages and a little switching cost.

Intangible assets do not always relate to a company’s branding. For DaVita Inc., it is its extensive network of dialysis centres and convenient locations in the U.S., a reputation for high-quality services and entrenched relationships with the physicians.

Given that patients will require dialysis treatment for three to four hours per day, three times per week for the rest of their lives or until they get a successful kidney transplant, convenience is a major factor for physicians and patients to consider for their treatment plan and facility. For that, DaVita Inc. has built a network of dialysis centres in convenient areas to serve patients effectively. We can also observe a little switching cost related to the convenient locations. This is because, once a patient chose a convenient dialysis centre, they will have very little incentive to switch to another location or provider.

DaVita Inc. has a reputation for continuously delivering high-quality services for its patient. This is in alignment with the care quality and patient survey done by the Centres for Medicare and Medicaid Services rating clinics in the U.S. This consistent care quality is particularly important as it influences physician referrals. This relationship with referring physicians also strengthens its intangible assets.

Besides those intangible assets, DaVita Inc.’s size helps scale-related cost advantages such as having stronger negotiating power for its supplies.

Looking at the perspective of treatments per facility, DaVita Inc. also gained a cost advantage over other smaller dialysis providers. The company operates at higher potential capacity and higher utilisation with lesser employees as compared to the other smaller dialysis providers. Additionally, DaVita Inc. can spread its general and administrative costs over a larger base of clinics than smaller providers. All these factors help reduce the overall cost per treatment which lead to the company generating more economic profits.

Despite having intangible assets and cost advantages, I only assign a narrow economic moat because the company still lack other sources of moat.

DaVita Inc.’s performance is only satisfactory. Although its revenue grows consistently over the past 5 years with its gross margin hovering steadily at the 30% range, which is around the industry average, the company earnings and operating cash flow are inconsistent. DaVita’s net margin is also inconsistent year over year.

DaVita Inc.’s ROE looks impressive at 80.8%, almost 6 times higher than its industry average of 13.0%. However, if you investigate deeper, the metric is probably skewed due to their high level of debt. The company does not perform well for its ROIC too. Even though the current ROIC is above its WACC, it does not achieve a minimum of 12% consistently over the past 5 years. These factors may suggest that DiVata Inc. has a weak capital allocation.

DaVita Inc.’s balance sheet is not ideal. The company meets 2 out of 4 of my requirements for a stable financial health. Beyond my 4 requirements, the company’s debt-to-equity has increased 3 times over the past 5 years to a current level that is considered high. Its cash-to-debt and equity-to-asset are unacceptable as well, operating less than the industry average.

With a narrow moat, satisfactory performance and poor capital allocation and balance sheet, I will give a 50% margin of safety. So, with an estimated intrinsic value of $162.86, I will only purchase the stock when it is trading at a range of $82.